Time for a Closer Look at the Deficit

September 14, 2004

By Steve Rosenbush To hear critics on both the left and the right tell it, President Bush has allowed the federal deficit to soar. The surplus that he inherited from President Clinton in January, 2001, is long gone. Economists estimate that the budget gap for fiscal 2004 will top $400 billion. Measured in absolute dollars, that's the widest in U.S. history.

What's more, the White House conveniently omitted the costs of fighting the war in Iraq, claiming it doesn't know how much they'll be (although the amount already exceeds $100 billion). It also assumes that the tax cuts won't be made permanent, even though Bush is sure to make their continuation a top priority, if he's reelected.

From the right, blogger and columnistndrew Sullivan, lamenting "the end of conservatism," has cited Bush's spending in a lengthy explanation of why he won't support the President for a second term. And on the left, New York Times columnist Paul Krugman, long one of the President's fiercest critics, says Bush is profligate -- and a liar to boot (for more, see BusinessWeek Online's political blog, Party Lines).

UNWISE DIVERSION. Krugman is particularly incensed that the White House is touting new numbers that show this year's deficit won't be as big as Bush first predicted. The Administration says the new forecast shows the economy is growing and that revenues are rising as a result of its tax cuts. Krugman charges that the February estimate of $521 billion was deliberately exaggerated so that as the election nears, the White House could claim the fiscal outlook is improving. Indeed, it now forecasts a deficit of $445 billion for 2004.

As controversial as Bush's fiscal policies have become, a closer looks suggests that alarms are somewhat overdone. Yes, the deficit is unsustainably high. And by providing investors an easy, risk-free place to plunk their cash -- in Treasury notes -- the soaring deficit diverts too much money that could be more wisely invested in new jobs, plants, and equipment.

Over time, if it continues to balloon, it will become a serious drag on the economy and the stock market. And there's probably some truth to the charge that the Administration is gaming public expectations over the deficit for maximum political benefit before November.

"REASONABLE PROSPECTS." Yet for all the legitimate concerns, the fiscal hawks fail to put Bush's fiscal performance in proper perspective. The red ink for 2004 won't flow as freely as expected, according to the two independent economists, David Wyss of Standard & Poor's (S&P, like BusinessWeek Online, is a unit of The McGraw-Hill Companies) and Gus Faucher of Economy.com. Plus, they both believe the deficit will fall every year through 2008.

Their forecasts assume that some or all of the tax cuts will be made permanent and that the U.S. will keep spending billions of dollars a year to fund the war in Iraq. "This year is going to be the worst deficit, and it's coming in better than we expected," says Wyss. "Even assuming the tax cuts are extended, there are reasonable prospects for the budget deficit to close over the next six years."

Wyss says it's difficult to forecast exactly what the deficit this year will be, but he expects $422 billion -- which would set a new record. But it should be less than the $480 billion Wyss originally predicted. He expects the gap to narrow to $318 billion in 2005 and $240 billion by 2008, thanks to improved corporate earnings and lower-than-expected inflation. And says Faucher: "Our near-term forecast is for smaller deficits over the next couple of years. Tax revenues are going up because the economy is strengthening."

BOOMER BUST? Measured as a percentage of gross domestic product, this deficit isn't as catastrophic as it looks. At $422 billion, it would amount to 3.3% of GDP, according to Wyss. In relative terms, 1983's $195 billion deficit still stands as the highest in the nation's history, accounting for 5.7% of GDP. By next year, Wyss expects the U.S. deficit to fall to 2.8% of GDP, coming in below the 3% ceiling that the European Union has established for its members as a safe gauge.

None of this suggests that the deficit isn't a problem. Economists, including Wyss and Faucher, are worried that it might spike up toward the end of the decade, as baby boomers begin to retire, drawing heavily on entitlement programs for seniors that could increase federal spending dramatically.

If their fears are borne out, the U.S. could soon face the difficult choice of reducing spending or raising taxes. But for the next few years, it appears the deficit won't be quite the fiscal bugaboo that some fear. Rosenbush is a senior writer for BusinessWeek Online in New York